The plan is optional upon agreement between carrier and insured. The plan adjusts the premium on the basis of losses incurred during the policy period. The intent is to charge a premium which reflects those losses, plus carrier expenses. Retrospective rating establishes the reasonable cost of insurance by using losses incurred during the policy period and adding the carrier's expenses and taxes on premiums.
The Retrospective Rating Plan is now an optional license for carriers to purchase from NCCI. It is not part of the required affiliation services.
Retrospective Rating is a plan for adjusting the risk premium of a policy according to the loss experience during the effective period of the policy. At the simplest level, an insured's retrospective premium is determined by the formula: R = (B + cL)t, where
R = Retrospective Premium, subject to minimum and maximum amounts
B = Basic Premium
c = Loss Conversion Factor, generally reflecting loss adjustment expense
L = Actual incurred loss during the effective policy period
t = Tax Multiplier
R is not known until after the policy has expired and the actual losses are fully developed.
The Basic Premium contains provisions for the expenses of the carriers. It also includes an insurance charge to compensate for the times losses exceed an amount leading to the maximum premium, but reduced by the average savings resulting from the times losses are less than a minimum provision that may be in the plan. The source of the values used to determine the charges and savings is the Table of Insurance Charges.
The Table of Insurance Charges is the portion of losses in excess of those resulting in the maximum premium, where the limitation is expressed as a ratio to expected losses called an Entry Ratio. The charges depend not only on the loss limitation, but also on the size of the insured. The variation in the loss ratios of the large employers who expect many losses should be much lower than the variation for small employers.
The State and Hazard Group Relativity Factors help determine the Expected Loss Size Range, which affects the selection of the column of the Table of Insurance Charges. This then impacts the basic premium portion of the retrospective policy premium.
The State and Hazard Group Relativities should be updated regularly due to changes in the circumstances (changes in state statutory benefit levels, inflation, etc.) underlying each state's severity.
The premium eligibility level for Retrospective Rating was changed via item R-1233, effective 10/1/88. Previously, the eligibility level was at $5000 for a one year plan; $10,000 for a three year plan. Some of the tabular plans effective in Indiana from 1985 on (they're no longer available as of 12/91) provided rating values for one year plans that began at premium levels considerably higher than the eligibility level. This was due to the fact that the actuaries could not develop credible, balanced rating values at the lower premium levels. For that reason, and the fact no one really wrote retros at $5,000, the eligibility level was increased to $25,000 for one year plans; $75,000 for three year plans. In today's current market, the vast majority of retros are written for risks in the $100K+ premium range. Indiana did approve this item effective 10/1/88.
For additional understanding on retros, you may want to view NCCI's webinar: